The Owners Have Decided To Go Public And Issue an IPO They Issue 3
The Owners Have Decided To Go Public And Issue an IPO They Issue 3
The owners have decided to go “public” and issue an “IPO”. They issue 30 million shares at $2.00 each, with the payment structure as follows: $0.80 per share on application (closing 18th April 2013), $0.50 four weeks after allocation (allocation date 13th May 2013), and the remaining amount payable on 30th July 2013 (call made on 30th June 2013). The IPO receives requests for 30.4 million shares, exceeding the allowable 30 million shares, leading the directors to adopt a “first-come, first-served” approach, returning excess applications to unsuccessful applicants. All monies were assumed received on 18th April 2013. Understandably, the decision to return the excess application funds stems from both practical and ethical considerations. The primary rationale is to ensure fairness and transparency in the allocation process, especially when demand exceeds supply. Returning excess funds prevents potential disputes among applicants and maintains the integrity of the IPO process. Furthermore, it simplifies bookkeeping and audit processes by only acknowledging funds related to successfully allocated shares. Alternatively, the directors could have explored different options for handling excess demand, such as prorated allocation or oversubscription management strategies, but these also involve complex calculations and potential dissatisfaction among investors.
Journal Entries for the IPO Events
1. Receipt of Application Money (18th April 2013):
Since all application monies were received on 18th April, the entry reflects the total amount received for the applications:
Bank Dr. $24,320,000
To Share Capital (30 million shares x $0.80) $24,000,000
To Share Application Money (Unearned) $320,000
This entry records the receipt of application funds net of the portion to be allocated upon successful share issuance. The remaining $0.50 and the final payment scheduled for later are not yet recognized as income or share capital.
2. Allocation of Shares (13th May 2013):
Based on the first-come, first-served basis, the first 30 million applications are allocated shares, and excess applications are returned. The application money pertaining to the allocated shares is transferred from the unallocated account. The excess application money (those not allocated shares) is refunded.
Funds allocated to successful applicants:
Share Capital (30,000,000 shares x $2.00) $60,000,000
To Share Capital (at $0.80 per share on application) $24,000,000
To Share Premium (difference between issue price and application) $36,000,000
The remaining application money not allocated, i.e., the excess, is refunded. The journal entry for refunded application money:
Share Application Money (excess applications) $320,000
To Bank $320,000
Note: The total application money (£30.4 million applications at $0.80 = $24.32 million) is received. The first-come-first-served method limits to 30 million shares, so the excess applications are refunded promptly after allocation.
3. Payment of the $0.50 per share (4 weeks after allocation, around 10th June 2013):
On receipt of the second payment, the journal is:
Bank Dr. $15,000,000
To Share Capital (30,000,000 shares x $0.50) $15,000,000
This captures the second installment from shareholders who have committed to pay the second installment. The share capital account remains credited for the total paid-up amount of $2.00 per share.
4. Final Payment on 30th July 2013 (Remaining amount):
Once the remaining amount ($2.00 - $0.80 - $0.50 = $0.70 per share) is received, the journal is:
Bank Dr. $21,000,000
To Share Capital (remaining $0.70 x 30,000,000 shares) $21,000,000
This finalizes the shareholder’s payments, completing the total amount payable per share. The share capital
account now reflects the full paid amount of $2.00 per share.
Alternative Options for Handling Excess Demand
Aside from applying the "first-come, first-served" approach, the directors could have considered other methods to manage excess demand. One common alternative is a prorated allocation, where applications are scaled proportionally based on total demand. For example, with 30.4 million applications but only 30 million shares available, each applicant would receive shares proportional to their application size. This method is perceived as fairer, especially when large investors apply, but it can be complex to administer and may discourage some applicants due to perceived unfairness.
Another approach involves oversubscription management, where the company accepts more applications than available shares under the bridge of a tentative oversubscription, and then allocates shares based on predetermined criteria or lotteries. Though this may introduce randomness or bias, it can be attractive from a marketing perspective, generating longer-term investor interest.
Using a lottery system is yet another alternative, where applications are randomly selected to ensure fairness among all applicants. However, this method could lead to dissatisfaction among large investors who may favor proportional allocation, leading to potential reputational risks.
In respect of returning excess payments, the directors' choice aligns with legal and ethical considerations, ensuring transparency and fairness, particularly in protecting smaller investors. Nonetheless, a combination of proration with a clear communication strategy might have balanced fairness with efficient resource management, although its complexity could have proven challenging for the company's administrative systems.
Conclusion
The issuance of shares through an IPO is a complex process involving meticulous record-keeping and transparent communication with investors. The journal entries described above illustrate the typical accounting treatment of application money receipts, share allotments, subsequent installment payments, and final cash collection. Managing oversubscription remains a crucial aspect, with various strategies offering different advantages and challenges. The directors’ decision to use first-come, first-served and returning excess funds is a straightforward, transparent approach, often preferred for its simplicity and fairness to smaller investors.
References
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